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Keynesianism and Monetarism

Accepted truth from 1776 to 1929: the “invisible hand” of the unrestricted free market is the best regulator of the economy. The economy expands, contracts, expands in natural cycles. Government should stay out of the way, balance its budget (no deficits), and keep taxes low. This is called “laissez faire” (pronounced lay-zay fare). These ideas are most associated with the British economist Adam Smith who wrote a book called The Wealth of Nations (1776).

Then came the Great Depression from 1929 to various points in the Thirties. Thousands of bank failures, tens of thousands of bankrupt businesses, millions of unemployed people, and year after year of hardship with no hope in sight. The “invisible hand” seemed too invisible for most people’s liking.

Accepted truth from 1933 to 1973: Recession (bad) and Depression (worse) result from a shortfall in Demand (people wanting to buy stuff) compared with what the economy can actually produce. Government should make up the difference by spending money to buy stuff. Also, if a government ran a budget deficit in the process of reviving the economy, it was all right and not the end of the world. So, the government could manage the economy, do lots of things for citizens, and let the politicians decide how much to spend on what. These ideas are most associated with the British economist John Maynard Keynes (pronounced Kanes) who wrote a book called The General Theory of Employment, Interest, and Money (1936). So this is called “Keynesianism.” By the mid-Sixties everybody was a “Keynesian.”

Then came the Seventies. The “oil shocks” of 1973 and 1979 caused world-wide “stagflation”: a combination of high inflation and high unemployment. In economic theory, this could not happen. In economic reality, it could happen. People observed that big government deficits dumped gasoline on the fire of inflation, while lots of government control of the economy blocked adapting to new conditions.

Accepted truth from 1973 to 2008: the money supply and interest rates really govern the economy. Deficits are bad because they either dump excess money into the economy (fueling inflation) or “crowd out” businesses that want to borrow money (smothering economic progress like a wicked step-mother). The government should balance budgets, cut spending, cut taxes, keep interest rates low, and let the natural economy function. These ideas are most associated with the American economist Milton Friedman who wrote a book called The Monetary History of the United States, 1867-1960 (1971). So this is called “Monetarism” (rather than “Friedmanism”).

Then came the “Great Recession” of 2008-201_ (fill in blank when you get a job). Unregulated bankers did a lot of, you know, silly things. The world financial system almost collapsed. We’ve got seven percent unemployment. Monetary policy isn’t working: the interest rate is at about zero, but the banks still aren’t lending; my 401(k) is only now back to where it was in 2008. So, what is to be done? Ask Keynes.